Central bankers should stick to their knitting

In a Senate Finance Committee hearing held Tuesday, January 22, Jim Bunning, R.-Ky., exploded after Congressional Budget Office director Peter Orszag noted that "Chairman Bernanke and many economists" believe that the risk of a recession in 2008 "is substantially elevated relative to normal conditions." Bunning bellowed: “Please don’t bring Chairman Bernanke into this, because he’s been wrong so many times … Chairman Bernanke and his predecessor put the U.S. economy in this situation by their monetary policy. And now they are getting into the business, the Federal Reserve, into advising the Congress on fiscal policy, which is none of their darn business. So, I get a little upset sometimes when our Federal Reserve gets into our job, which is to try to stimulate the economy if we think it’s in dire straits.”

Senator Bunning has a point.  To borrow a felicitous phrase of Alan Blinder: central bankers should stick to their knitting.

Chairman Bernanke has played a prominent, high profile public role in gathering support for a fiscal stimulus package to counteract the US slowdown/recession.  On Thursday, January 17, for instance, in testimony to the House Budget Committee, he backed calls for a fiscal package to stimulate economy, but stressed such a plan should be "explicitly temporary." … "Any program should be explicitly temporary, both to avoid unwanted stimulus beyond the near-term horizon and, importantly, to preclude an increase in the federal government’s structural budget deficit," He went on to say that the nation faced daunting long-run budget challenges associated with an aging population, rising health-care costs, and other factors, and that a fiscal program that increased the structural budget deficit would only make confronting those challenges more difficult. "Fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone," .

Chairman Bernanke may be right or wrong about the usefulness of this kind of fiscal policy package, but he should keep quiet about it regardless.  It is not part of his mandate and it is not part of his competence to make fiscal policy for the US. This is not the first time the Chairman of the Fed has strayed into controversial policy issues that are none of his and the Fed’s business.  He has lectured, as Chairman of the Fed, on free trade, on aspects of globalisation that are not relevant to the conduct of monetary policy, on  equality, equality of opportunity and teenage pregnancy. 

This kind of mission-and-mandate-creep by the Chairman of the Fed is dangerous. It threatens his current and future capacity to do the job he was appointed for: to chair the Committee in charge of making monetary policy for the US and to manage the Fed.

Central bankers tend to go ballistic when ministers of finance or the economy, prime ministers or presidents lecture them on how to conduct monetary policy. This is an entirely reasonable response.  Even the President of the European Central Bank, Jean-Claude Trichet, lost his usual Gallic good manners when, during the press conference following the ECB’s governing council meeting, a journalist plugged into her Blackberry informed him that President Sarkosy of France had claimed credit for influencing the ECB’s decision to keep the policy rate constant rather than raising it.

Politicians should not try to influence or even to comment on the monetary policy implemented by an operationally independent central bank. But what’s good for the gander is also good for the goose.  It is also a mistake for central bankers to express, in their official capacities, views on what they consider to be necessary or desirable fiscal measures and structural reforms. Few heads of central banks resist the temptation to use the unrivalled pulpit provided by their central bank appointments to give the world the benefit of their two cents worth on any subject under the sun.  I have already mentioned Chairman Bernanke’s many transgressions. Alan Greenspan liked to pontificate on social security and the minimum wage when he was Chairman of the Board of Governors of the Federal Reserve System. Jean-Claude Trichet cannot open his mouth or a admonition about fiscal sustainability and the need for structural reform rolls out. There are but a few examples of central banks that do not engage in public advocacy on fiscal policy and structural reform matters. The only examples I am aware of are the Bank of England and the Reserve Bank of New Zealand.

Once again, these peregrinations outside their mandates and domain of competence represent an unacceptable form of  mandate-and-mission-creep by the central bank.   The regrettable fact that the Treasury and the Ministry of the Economy tend to make the symmetric mistake of lecturing the operationally independent central bank on what they perceive to be its duties (which generally amounts to a plea for lower interest rates) does not justify the central bank’s persistent transgressions.

Central bankers indeed have a duty to explain how their current and future interest rate decisions are contingent on economic developments that may include or may be influenced by, the actions of the fiscal authorities and the success or failure of structural reforms. The central bank should clarify what its reaction function is, given the economic environment in which they operate, which includes the fiscal authorities and the government and ‘social partners’ engaged in structural reforms.

But Chairman Bernanke’s deeply political and at times partisan interventions in often controversial public policy debates well beyond the domain of monetary policy politicise the Fed.  This increases the risk that the Fed, already the least independent of the leading central banks, will become even more constrained in its ability to pursue its legal mandate as is sees fit, without undue hindrance from the Congress or the Executive.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website